As the world began the recovery process after the 2008 financial meltdown, emerging markets proved to be a bright spot. Countries like India, China and Brazil were able to deliver rapid economic growth and double-digit stock gains. There is a possible downside for those who venture into exotic markets: the risk of large, unforeseen losses. For example, from January through November 2011, emerging market funds sank 15.6% versus a gain for the S&P 500 of 0.4%.

Is there a way to capture the developing world’s rapid growth while avoiding downsides along the way? We have recently seen the emergence of several exchange-traded funds (ETFs) which track stock indexes made up of dividend payers in emerging markets. For example, WisdomTree Emerging Markets Equity Income was down 9% in 2011, and SPDR S&P Emerging Markets Dividend began last February and had a three-month loss of 13.8%. The benchmarks followed by such ETFs yield around 7%, compared to around 2% for the S&P 500.

As a rule, you should be skeptical of new funds which seemingly promise you can have you cake and eat it, too. Focusing on income might seem to be counterintuitive here, because dividends are usually associated with slower-growing companies. But in emerging markets, dividends are often seen as a show of strength. Dividend payers have sufficient supplies of money to grow, and thus do not need to issue new stock to raise capital, which dilutes the value of existing shares.

If you are thinking about investing in these funds, here are some things to consider:

You cannot count on steady income.

There is no guarantee these funds will continue with yields close to 7%. The risk of ups and downs caused by political and economic instability can diminish your payouts.

They can carry somewhat higher expenses (for example, 0.63% of assets for DEM, versus just 0.22% for Vanguard MSCI Emerging Markets ETF.) You will also pay overseas taxes on distributions, but taxable investors who itemize are eligible to get a foreign credit or claim a deduction.

You will not get full diversification.

Funds which screen for high payers must often focus their bets. For example, DEM has around 40% of its assets in Brazil and Taiwan, while roughly 25% of their portfolio is in financials. You might want to split your investment in emerging-markets between dividend ETFs and more diversified offerings. One more thing to consider: given Wall Street’s knack for messing up good things, if you are thinking about trying a dividend strategy, you might want to consider acting now before the architects of EFTs get a chance to mess things up.

Please discuss with your financial planner to determine whether or not these kinds of ETFs are appropriate for your individual risk tolerance level.

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